Rating- buy - SBI- strong returns amid uncertainties

Rating: buy | SBI: strong returns amid uncertainties

The State Bank of India (SBI) reported an 8% year-on-year (y-o-y) growth in earnings, despite an 8% y-o-y decline in operating profit. This decline was primarily due to increased provisions for wage settlements. 2QFY24, however, exhibited fewer pressure points compared to its peers. SBI maintained a robust return on assets (RoA) of 1% and a strong return on equity (RoE) of approximately 16%.

In 2QFY24, asset quality concerns remained low, and the bank’s credit risk from unsecured loans continued to decrease. Net interest income (NII) increased by 12% y-o-y, driven by similar loan growth, with faster growth in SME loans and a slowdown in unsecured loans. The Net interest margin (NIM) remained flat q-o-q, in contrast to most other banks experiencing higher pressure. Return on equity (RoE) stood at approximately 16%, and Return on assets (RoA) was at 1.0%. The bank also increased provisions related to wage settlements from 10% to 14%. Tier-1 capital (excluding 1H PAT) is at 12%, with CET-1 at 10%.

A key challenge in investing is identifying the right narratives for a stock, particularly when seeking a re-rating event. Historically, RoE reversals driven by changes in credit costs have played a crucial role. However, this pattern does not hold for SBI. Currently, SBI boasts RoE levels nearing 15-year highs and has the lowest credit costs in the past 25 years. Despite these positive indicators, the bank trades below book value (one-year forward), and we are cautious about certain unconfirmed concerns.

Our ongoing debate revolves around factors such as relatively lower capital adequacy levels, the composition of the loan portfolio with unsecured loans, and the ongoing NIM contraction cycle. While we acknowledge these risks as valid concerns, we are still uncertain about the severity of their potential impact, even if they materialise. We remain committed to our investment thesis, especially considering that we are in the early stages of the next credit cycle. We believe that the bank has the resilience to weather this narrative and continue delivering strong return ratios.

Maintain BUY

We maintain a BUY rating with an unchanged FV of Rs 725, valuing the bank at 1.3X (adjusted) book value and 8X FY2025E EPS, targeting RoEs of approximately 15%. Our estimates remain unchanged, but we anticipate potential upgrades, particularly in credit costs. Forecasting credit costs is a challenge, but we are currently in a period of low credit costs. The composition of the loan portfolio suggests that the impact of these costs is unlikely to be as severe as during the corporate cycle. The bank is growing its loan book more cautiously, providing added confidence. The impressive liability franchise bodes well for credit costs. We believe that current valuations do not fully capture the strengths of this franchise. As the quality of earnings continues to positively surprise, we expect the bank’s stock to trade at higher levels, potentially for a longer duration than anticipated.